Mortgage loans create additional liquidity in the real estate market and thereby support real estate property values and facilitate transactions. Increased liquidity lowers interest rates, allows for a greater number of transactions to occur, and affords larger loan amounts than otherwise possible. Notably, new mortgage transactions fund property acquisitions as well as the repayment of mortgage loans at or before their final maturity.
Since 1985, both the residential and commercial mortgage markets benefited in certain ways from new business methods that encouraged and enabled capital investors worldwide to fund mortgages without having property-specific knowledge at the once-standard level of detail. Through these new methods, investors could acquire publicly registered securities, the majority amount of such securities formally rated by third-party credit rating agencies (“CRAs”), such ratings in effect serving as a substitute for investors developing their own direct understanding of the overall level of investment risk. This mortgage “securitization” process, whereby pools of mortgage loans are funded by issuances of fixed income securities (i.e., mortgage-backed securities, a/k/a “MBS” for residential and “CMBS” for commercial), increased the supply of mortgage capital by bringing rated as well as unrated bond investors newly into the universe of mortgage investors. These bond investors entered the mortgage market because a.) the securitization methods provided a familiar form of investment (i.e., rated and unrated publicly registered bonds) which they could buy or sell in an established secondary trading market through trading desks at major investment banks, and track the market through various independent data services such as Bloomberg; b.) the securitization methods seemed to minimize if not eliminate exposure to property- and market-specific investment risk by having geographic and other types of diversity across loan pools; and c.) the securitization methods seemed to allow total investment risk to be quantified and rated by ostensibly expert independent agencies. Thus, initially and for several years through most of 2007, the methods seemed to make investments in pools of mortgage loans directly comparable to the entire universe of non-mortgage bond investments. As a direct result, during this period, residential and commercial mortgage loans became more available to average borrowers, generally bore lower interest rates, and were funded in higher amounts on a given property, relative to earlier periods. This occurred as a direct result of the acceptance of mortgage-backed securities as investment grade fixed income investment by investors who would not otherwise have provided anywhere near the same amount of capital to fund real estate industry mortgage demand.
Between 1989 and 2007, the mortgage market grew tremendously in terms of both the amount of capital invested in these pools of loans and the complexity of the securities issued by loan pool owners, in both MBS and CMBS categories. Predictably, increased liquidity drove total loan fundings up, both in aggregate and at the individual loan level, and drove interest rates down. The greater supply and lower cost of mortgage capital decreased real estate buyers' total cost of capital; a lower total cost of capital fueled a major upward trend in real property values.
In early 2007, with property values reaching historic highs and interest rate declining to historic lows, the CRAs as well as many investors became concerned that the CRA risk ratings as applied to previously issued mortgage-backed securities did not accurately reflect their true bond investment risk. By late 2007, this concern had become so prevalent and so acute that little if any new capital was flowing into the mortgage capital market, and trading of issued securities slowed markedly. Previous MBS and CMBS investments began dropping in value as a clear indication of this concern and the concomitant decrease in liquidity. In short order, the entire market of highly sophisticated mortgage-backed bond investors had re-evaluated their investment risk positions and came to understand two realities. First, they realized that, irrespective of the CRA ratings, their risk was inevitably and directly related to the value of the properties which served as ultimate security for the pooled loans; second, they realized that the scale and structural complexity of the mortgage pools supporting their bonds, and the total scale of the MBS and CMBS market, virtually precluded any definitive risk analysis updates. In plain terms, there was no practical way to “go back”, gather up, and understand the property-specific knowledge they needed to assess their investment risk. The ensuing collapse of the mortgage-backed securities market and the weakening or failure of many related institutions began as a re-pricing of bond risk, proceeded to become a self-propelled cycle of devaluation in property values, and quickly brought about the current disastrous situation among the many financial institutions holding large portfolios of mortgage loans. In short, the current situation is defined by many financial institutions having to take into account severe losses in the value of their mortgage loan holdings and acute declines in the profitability of their lending operations to the point that the expenditure or investment of untold hundreds of billions of dollars of taxpayer capital appears necessary, over an indeterminable time period, to support or take over those institutions.
Many of the lending institutions referred to above are regulated or overseen by one or more of several government departments, public agencies, and regulatory bodies, including among others the U.S. Treasury (“Treasury”), the Federal Deposit Insurance Corporation (“FDIC”), the U.S. Securities and Exchange Commission (“SEC”), and the Financial Accounting Standards Board (“FASB”) which sets Generally Accepted Accounting Policies (“GAAP”). We refer herein to each such institution as a “Lender”. We refer to all the laws, regulations, guidelines, standards, and policies under which a Lender operates as “Regulations”.
US Patent Application Publication No. 2008/0109347 (herein “the '347 Publication”) dated May 8, 2008 discloses a system where a single new mortgage loan is computed to provide a requested level of financing. This system described a loan which is secured by a first mortgage that may be bifurcated into at least two promissory notes—a senior note and at least one junior, subordinated, “Hyper-Note”. By the method described in the '347 Publication, the amounts, term, maturity, rates of interest, and amortization schedules of the first mortgage loan and the Hyper-Note can be iteratively determined according to a selected loan construction paradigm. It was through this system, or similar methods, that many individual loans were constructed between 1989 and 2007.
However, the system described in the '347 Publication only focuses on individual new loan originations and fails to address the complexity of many financing situations, such as the unanticipated problems related to today's severe capital market distress, and does not adequately take into account the regulatory environment in which most Lenders operate. In addition, the '347 Publication sets up as important premises that mortgage funds have historically been scarce, sources arcane, supply “lumpy”, a situation the emerging CMBS marketplace was “only beginning” to change, in support of the assertion that the Hyper-Note method would facilitate loan originations.
In sharp contrast to the context of the '347 Publication, the reality of the current market is that the development and execution of securitization methods and systems (including the system described in the '347 Publication submittal) proceeded apace, demonstrably resulting in an excess of mortgage funding—at least as measured relative to the investment risk taken by investors funding those mortgages. Further, as noted above, such excess sparked investor recognition of the imperfections across the investment class, particularly in the structuring and rating of loan risk, and abandoned the MBS and CMBS market almost entirely. As of the date of this application, this investor exodus has directly and drastically reduced the amount of available mortgage capital, the number of transactions, and the potential loan amount for a given property. Indirectly, the dramatically lower liquidity in the mortgage capital market has disproportionately increased the cost of capital across the entire real estate sector. This higher cost of capital has reduced real estate asset values sharply, well beyond the discrete impact attributable to a cyclical economic slowdown. In a continuing vicious cycle, lower property values have made previously funded mortgage loans much riskier than they were at the time of origination, in terms of the most reliable risk index available within the real estate lending industry, i.e., the loan to value (“LTV”) ratio.
More specifically, in the current market a Lender holding a substantial portfolio of mortgage loans faces intense challenges:                1. to maintain risk-based regulatory capital adequacy to accommodate growth, avoid contraction, and preclude government takeover;        2. to start making mortgage loans again, in order to re-establish normal profitable operations;        3. to support profitable relationships with Borrowers, not only without the capacity to make new loans, but further burdened by responsibilities to pursue a costly adversarial judicial process to resolve defaults on existing loans; and        4. to build the confidence of investors and depositors who have normally been low cost sources of capital for Lenders.        
The current market also presents Borrowers with increasingly difficult challenges:                1. to find adequate replacement mortgage funds to meet contractual loan repayment obligations;        2. to secure sufficient equity capital to meet loan obligations and related guaranties;        3. to avoid the loss of their mortgaged properties through foreclosure, due to the unfortunate timing of their loan maturities relative to an extraordinary capital market anomaly, as compounded by a business cycle downturn; and        4. to preclude the adverse tax effects of foreclosure and debt forgiveness.        
As noted previously, and perhaps most importantly, it is a direct reflection of all of the difficulties cited above that the current market requires the government, thus taxpayers, to fund or expose previously unthinkable amounts of capital in support of Lenders. Pointedly, the risk in such fundings by the government is effectively little different from the risks in the positions once taken—and now abandoned—by private investors funding into the mortgage capital market. Indeed, there is no practical way for the government, in its effort to support Lenders hobbled by their difficulties, to assess property-specific loan risks any better than private investors did when they invested in mortgage-backed securities.
Current mortgage market conditions pertinent to this description involve many factors which constrain the ability of a Lender on its own to offer a new capitalization option to a Borrower. Specifically, in the current market, many loans held by Lenders, particularly construction or similar bridge financings, have reached or will soon reach their final maturity. Because of the economic downturn, the greatly reduced supply of mortgage capital, the substantially increased cost of capital in the real estate industry, and the attendant sharp reduction in real property values, many such loans reflect a LTV ratio much higher than regulations allow, and often high enough to trigger asset impairment charges under GAAP. This will have significant adverse impacts on the Lender's income (i.e., as necessary loan loss reserves are established, with commensurate reductions of current income), on its regulatory capital (i.e., as retained earnings are reduced and risk-based capital ratios decline), on its liquidity (i.e., as SEC-required disclosures discourage deposits and investment in public shares) and, in short order, its market value and ability to survive as an independent institution without government support. These adverse impacts will continue and, in many cases, will increase if such loans are simply extended as-is. The impact from a designated portfolio of such loans (e.g., those with the earliest maturity dates, or the highest LTV ratios) may be disproportionately large.
More pointedly, where a large portfolio of such loans are judged highly likely to reach final maturity with no possibility of repayment, resulting in significant impairment and the mandatory establishment by the Lender of larger loan loss reserves, it is also highly likely that worse will follow. To wit, the Lender will soon be forced to choose between two alternatives which both make matters worse—either simple loan term extensions, unattractive because the loan will remain on the Lender's books at an unacceptable LTV ratio, or a program of foreclosures on the collateral. An extension of a loan with a LTV ratio higher than regulatory guidelines will have the adverse effect noted above. A foreclosure program is very expensive and highly distracting of management attention, as a threshold matter, but even worse will force the Lender to choose between holding the collateral assets as Other Real Estate Owned (“OREO”) or quickly selling the foreclosed assets to third parties at sharply reduced market values from a disadvantageous negotiating posture. Under FDIC guidelines, the dollar amount of a Lender's OREO can have a greater adverse impact in its regulatory capital calculations than simply extending the loan. The result of either choice during the current period would likely be net additional operating losses, a compounding of the adverse regulatory capital impact, and an increased likelihood that government support or a takeover will be required.
It is worth noting further that reductions in a Lender's regulatory capital and incremental economic losses are often a matter of public record and typically a focus of avid media interest. Such publicity almost invariably results in a further loss of consumer confidence and withdrawals of cash from the Lender by its depositors. The combined effects of real economic losses and broad loss of depositor and investor confidence can easily result in a downward spiral into failure, at great expense to taxpayers. The cumulative effect of many such failures is a huge burden on government resources, and demonstrably has a marked adverse impact on the entire economy.
From the foregoing, there is clearly a need for a system that constructs multiple loan packages according to a paradigm which puts a large measure of property-specific loan risk into the hands of investors who are capable of making a proper assessment of that risk and funding new capital against that risk, for each and every loan involved, in a way that is consistent with regulations and which will at least supplement if not wholly supplant the indeterminate amount of capital otherwise required of the government and its taxpayers. The system would also need to mitigate specifically the component of loan risk related to Borrower repayment obligations occurring in periods of diminished mortgage capital supply and extraordinarily high mortgage capital costs.
More specifically, such a system needs to provide a way to extend existing loan maturities while taking fully into consideration: a.) the myriad of regulations affecting Lenders holding such loans; b.) the various property-specific risk factors associated with each loan; and c.) the availability of capital from sources who can understand each loan's risk factors adequately to price the investment of new capital within established mortgage amounts. By facilitating loan term extensions, effectively disaggregating the risks specific to each loan and matching appropriate new private capital from unregulated investors to the disaggregated risk positions, such a system allows Lenders to reduce their exposure to risk in their mortgage loan portfolio with a minimum amount of governmental capital, applied efficiently. Such a system also: a.) shifts Borrower repayment obligations to future periods of greater overall financial stability; b.) increases the total amount of private capital in the mortgage market; c.) facilitates a greater number of mortgage transactions; d.) supports higher loan amounts on a given property; and e.) reduces the cost of mortgage capital, thus the industry's total cost of capital. All of these results tend to normalize real estate values and enhance the capital adequacy of Lenders, as well as arguably easing the overall financial stability of the entire economy beyond the real estate industry. The system is useful not only during the current market tumult but also consistently through periods of economic growth and stable mortgage markets as an enhancement of prior securitization systems and techniques.